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Eurobonds or external bonds - What are the benefits of investing in eurobonds?

A Eurobond is a fixed debt instrument that is issued in a currency that is required by the issuer but outside the borders of the currency’s country. They are not to be confused with Eurobonds (stable bonds) issued in the EU collectively by the Member States and European Central Banks. The eurobonds we are talking about are also known as "external bonds" because they are issued in external currencies in another country. They are usually attached to the currency they are issued in, such as eurodollar bonds or euro-yen bonds.

Learn from our article what eurobonds are and what they could do for you:

What are international bonds?

In order to evaluate eurobond investments, we need to understand international bonds. International bonds encapsulate a variety of types, and eurobonds happen to be one of them. International bonds are issued by non-domestic companies or governments. More and more issuers, especially corporations, are looking to borrow globally as a means of financing their operations, growth, and eventual expansion.

Understanding international bond

The aim of issuing international bonds is to reach more investors globally and to reduce regulatory constraints. As interest rates vary in different countries, international bonds can be included in your portfolio for diversification.

However, there are heavy risks associated with international bonds. For instance, the trading cost for international bonds is higher and requires a broker. As international bonds are spread between different countries, you will be exposed to the risks of each state, known as sovereign risks, which include political, economic, and other risks faced by the country. You will also be exposed to currency risks.

Categories of international bonds

There are three kinds of international bonds based on the issuer's country, the investor's country, and the currencies used to trade with them, namely:

  • Global bonds
  • Brady bonds
  • Eurobonds

Global bonds and Eurobonds are somewhat similar, but global bonds have other features. Eurobonds are traded in currencies that are not the company's home currency, while a global bond can be issued and traded in the currency of the issuer's country or in the currency of the country where it is issued.

Global bonds

Global bonds are usually issued by multinational companies in several countries at the same time. They are generally issued with a high credit rating, and the purpose of issuing global bonds is to reduce the borrowing costs. Global bonds are issued in many different currencies, pertaining to the currency of the country issuing them. For example, a French corporation could issue global bonds in the UK in UK pounds and in Germany in euros.

While global bonds were a good option for portfolio diversification in the past, they have seen a sharp drop in recent years, far worse than the fall in the 2008 financial crisis. Global bonds have fallen 11% since early 2021 and lost almost $2.6 trillion in US dollars due to high inflation.

Brady bonds

Brady bonds are issued by foreign companies and governments in US dollars and are backed by the US Treasury. As they are backed by the US treasury, they are able to offer higher interest rates and are seen as secure and attractive by investors. Brady Bonds were introduced by emerging markets as a bailout method in cases of default. Brady bonds, while profitable, are prone to credit risk, interest rate risk, and sovereign risk.

Eurobonds

Eurobonds are issued by a government or corporation offshore in an external currency. They are usually long-term, lasting from 5 to 30 years and typically come in USD. Although long-term, they can be sold before they mature. Eurobonds also offer some tax advantages for both the investor and the issuer. More about eurobonds will be discussed from here on.

What are eurobonds?

A eurobond could be used to help pay for a company's move into a new market in another country. The bond raises the money that is needed in the currency that is needed, without having to worry about the risk of the foreign exchange rate. Investors get a chance to invest in a foreign market while also investing in a well-known domestic company.

People who need foreign-denominated money for a set amount of time find eurobonds to be a good fit. This includes private businesses, international groups, and even governments. Eurobonds are usually sold with fixed interest rates, even if they are sold for a long time.

Definition & example of eurobonds

A Eurobond is a unique fixed debt instrument due to its characteristics. As such, the bond currency is different from the local currency of the country where it is issued. For example, a Japanese company can issue bonds in dollars, rather than its own currency, yen, in Japan to raise capital in US dollars. In this case, the eurobonds will be called eurodollar bonds because they are named based on the currency they are issued in. Eurobonds can be issued by a company, the state, or syndicates. They are handled by a syndicate of various financial bodies on the borrower’s behalf to underwrite and guarantee the purchase of the bonds.

How eurobonds work

There are various tiers of participants in the eurobond market. The issuer, or borrower, is the one who has to raise funds by selling bonds. A bank, a corporation, an international organisation, or a government contacts a bank to issue its bonds. This bank is referred to as the lead manager, and it may invite other banks to join it in forming a managing group that will negotiate bond terms and oversee bond issuance. The bonds will subsequently be sold to an underwriter by the managing group. The syndicate is made up of the three tiers of managers, underwriters, and sellers. The underwriter will buy the bonds at a low price and take the risk that they will not be able to be sold on the market for a higher price. The bonds are sold by the underwriter to a selling group, which then arranges them with investors.

The primary market for Eurobonds is comprised of syndicated businesses and their investor clients; once resold to general investors, the bonds enter the secondary market.

Following the issuance of the bonds, a bank serves as the primary paying agent, collecting interest and principal from the borrower and disbursing the interest to the investors. Frequently, the payment agent will also function as a fiscal agent on the borrower's behalf.

Eurobonds are exchanged over-the-counter in the secondary market. London, Frankfurt, Zurich, and Amsterdam are major Eurobond markets.

Why are eurobonds important?

Many corporations and organisations benefit from eurobonds due to their flexibility in issuing them in external currencies in their own country. The main reason for issuing a eurobond is to raise capital in a foreign currency to finance its operations. Imagine if a company in the US wants to enter the Chinese market to expand but does not have the capital in the local currency of Yuan. In such a case, the company can issue bonds in the US in Yuans in the hope of having Yuan holders buy the bonds and provide the capital it needs to enter the Chinese market. After the capital in Yuan is invested in China and yields a profit, the company can pay the lenders with fixed interest.

Eurobond vs foreign bond

Eurobonds and foreign bonds are two separate investment tools, but both the terms "foreign bonds" and "eurobonds" are used interchangeably. But there is a key difference between eurobonds and foreign bonds.

Foreign bonds require the issuers from another country to issue bonds in the local currency, whereas, eurobonds are issued in a foreign currency outside the country of the currency. For example, a Chinese company issuing bonds in dollars in the US foreign bond market for the local buyers to buy the bond. That is a foreign bond. In both cases, the issuers need external currencies, except foreign bond issuers are not local to the country, and they issue the bonds in a foreign country where they need their local currency. In comparison, eurobond issuers issue it in their own country but in a foreign currency.

Eurobonds advantages and disadvantages

Advantages of eurobonds for both investors and borrowers are discussed in the following:

  • Issuers can raise cash and lower borrowing costs by borrowing in international markets
  • Interest rate and currency conversion risks in overseas countries can be mitigated by issuers
  • These bonds provide investors a unique way to diversify their investments
  • Eurobonds also provide tax advantages to investors and involve less documentation from the issuers, which lowers the tax liability for investors
  • Companies can expand abroad with the help of these bonds
  • Because these bonds are issued on international exchanges, they are extremely liquid debt products

Eurobonds have a number of advantages, but there are significant disadvantages of eurobonds:

  • Investors may be exposed to regulatory risks when purchasing these bonds
  • For both investors and issuers, these bonds may pose a currency risk
  • Companies with lower credit ratings are not able to issue eurobonds
  • To diversify forex risks, investors may need to buy several different currency Eurobonds
  • Depending on the jurisdiction, investors may be solely responsible for filing tax estimates

Risks of eurobonds

Since eurobonds are international, the risks are mostly related to currency fluctuations. Despite the lack of currency risk, it is not completely eliminated. Currency risk has the highest possibility of affecting eurobond due to unfavourable exchange rates. However, investors can hedge such risks through currency futures contracts or options, where the investor locks on a fixed rate for buying or selling of the currency in the future. Although future contracts carry their own risks, which require their own research.

How to invest in eurobonds?

Bonds do not have a centralised exchange, unlike equities. Bonds are mostly bought and sold over the counter because of different issuers. The same principle applies to eurobonds.

Although most of the eurobonds are traded in the secondary market after their issuance, some of them can be bought and sold on public exchanges. For example, the London and Luxembourg stock exchanges share the biggest market for eurobonds, but you can also include Zurich, Frankfurt, Singapore, and Tokyo in the list.

However, it depends on the jurisdiction. For instance, Eurodollar bonds that are traded in US dollars cannot be sold to the public because they are not registered with the SEC, but they can be sold in the secondary market.

Many online platforms and online banks act as the base for secondary market offering eurobonds to the public.

What are the benefits of investing in eurobonds?

Eurobonds are growing and becoming more popular for smaller companies to raise capital. In fact, the largest portion of eurobond issuance lies with emerging markets, with both the government and companies wanting to take advantage of its flexibility. For issuers, the benefits of eurobonds are:

  • Flexibility to choose the country of the currency they need
  • Flexibility to choose a country with low-interest rates
  • Lack of currency risks
  • Flexibility to choose bond maturity period
  • Access to a market that would otherwise be impossible without eurobonds

For investors, Eurobonds are a way to expose them to foreign investments while staying in their own country. They are also cheap, very liquid and helps diversify their portfolios. The cost is low for investors, making it affordable to invest.

Summary

Eurobonds, or "external bonds," are a form of international debt instrument that allows a government or a corporation to gather capital globally. For borrowers, this is a low-cost method to not only attract money for their operations but to expand their business in other countries as well. It is important for both investors and borrowers because eurobonds offer a lot of benefits to both parties. But apart from the advantages, there are also risks to eurobonds. The eurobond market has several tiers; the borrower, the lead manager, and underwriters who work together to issue the bonds to the public. Eurobonds are an excellent way to diversify your portfolio.

If you follow the basic steps, Eurobonds can be beneficial for your portfolio. Emerging market governments and enterprises are increasingly issuing Eurobonds, as they seek deeper and more developed markets in which to borrow. Because many Eurobonds are unregistered and traded in bearer form, precise figures for the sector are impossible to obtain. However, as eurobonds are a high profit investment opportunity, it can be said that there are a large number of investors who hold them.

Last update: 05/08/2021

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